This article is one of a series being published by Divest Merge Acquire demonstrating ways M&A Advisors can assist business owners optimise their sale outcome.
When selling a business, one area that is often misunderstood is how employee entitlements are treated in a deal and this can cost you money.
Many lawyers and accountants do not fully understand how to calculate these, which can mean the seller loses part of the sale proceeds.
Employee entitlements can be classified in two ways during a sale, as third party debt or net working capital.
The degree to which employee entitlements can be classified as net working capital allows them to be transferred without being treated as a debt adjustment.
Liability items that form part of net working capital are the seller’s friend, as they become credits to reduce the net working capital requirement of the business. The lower the net working capital target, the higher the goodwill component of the purchase price.
Buyers would love all the employee entitlements to be treated as debt, deducting the total amount from the purchase price as a debt adjustment. Unsuspecting business owners can fall prey to this harsh and unfair treatment.
The extent to which employee entitlements are treated as debt, they are a deduction from the purchase price, which then should be mitigated by the implied future tax deduction available, which may be 70%-75% of the gross amount, depending on the company tax rate.
Here is how we recommend mutually fair treatment of the various entitlements
The 3 main element of employee entitlements are annual leave, long service leave and personal leave.
Personal Leave
Firstly, no adjustment should be made for personal leave, which is a contingent liability only. At most, only an indemnity could reasonably be offered to cover a nominated period after completion to the degree that the aggregate of personal leave taken exceeds the net new entitlement.
Annual Leave
The accrued employee annual leave entitlements of an employee:
(1) up to and 4 weeks accrued will be treated as a Working Capital Liability Item; and;
(2) in excess of 4 weeks accrued will be treated as a Third Party Debt and deducted from the purchase price,
Long Service Leave
The accrued long service leave entitlements of an employee:
(a) with less than 10 years’ service to be treated as a Working Capital Liability Item;
(b) with more than or equal to 10 years’ service but less than 15 years:
(i) will be treated as Third Party Debt up to 8.67 accrued weeks; and
(ii) will be treated as a Working Capital Liability Item for amounts in excess of 8.67 accrued weeks; and
(c) with more than or equal to 15 years’ service will be treated as Third Party Debt.
